Old precedent still important for determining tax residency
Percy Walker Thomson is no longer with us, but his legend lives on for setting the tax precedent to determine residency status. It all started back in 1923 when Percy decided to retire. He went back and forth between a permanent residence in New Brunswick and another in North Carolina, spending the winter months south of the border.
Thomson was familiar with the rules about tax residency. If he were deemed to be a resident of both Canada and the United States, he would be subject to both Canadian and American taxes on his worldwide income. Also, the Income Tax Act of Canada — known then as the Income War Tax Act — considered a person to be a resident throughout the taxation year if they were in Canada for 183 days or more during the year. Thomson always spent fewer than 183 days a year in Canada, and for many years was only taxed in the United States as a non-resident.
In 1941, the Canadian government asked him to file an income tax return for the previous year. Believing he was not considered a resident for tax purposes, Thomson decided not to heed the government’s request, ultimately resulting in the 1946 case of Thomson v. Canada (Minister of National Revenue – M.N.R.)  S.C.J. No. 5.
The case established that he was, in fact, a resident according to the Act and had to pay tax. The case also led to a new test for establishing a person’s residency for tax purposes. In addition to the deemed residency test, the Tax Court of Canada laid out a framework using the Thomson case as its basis for establishing factual residency, and these are the two tests that continue to be used today.
Under the factual residency test, one’s residency is determined using several factors, which are categorized as either primary or secondary. The three primary residential factors identified in the Thomson case are:
- The individual’s dwelling place(s).
- The individual’s spouse or common law partner.
- The individual’s dependent(s).
The secondary residential factors, or ties, considered under factual residency include:
- Location of personal property (e.g., furniture, automobiles, clothing).
- Social ties with Canada (e.g. recreational or religious memberships).
- Economic ties with Canada (e.g. employment, business activities, financial accounts, credit cards).
- Immigration status such as landed immigrant or valid work permits.
- Medical insurance coverage from a province or territory.
- A driver’s license from a province or territory.
- A vacation or seasonal dwelling in Canada.
- A Canadian passport.
- Memberships in Canadian professional organizations and/or unions
Meeting only one of the primary or secondary ties does not form the basis for tax residency, but the feds consider residential ties in aggregate. If a person meets the factual and/or deemed residency tests, they are a Canadian resident under domestic tax law and subject to Canadian income tax on worldwide income for as long as either test can be met. Then there is the U.S.-Canada Income Tax Convention (1980) — known as the Treaty — which provides “tiebreaker rules.”
The Treaty addresses these rules in Article IV, paragraph 2, with regards to those who meet the residence tests in both countries. The tiebreaker rules consist of four tests applied sequentially, and the first test to be met determines the country of residence for tax purposes.
For example, the first tiebreaker rule refers to the person’s permanent home — “if he has a permanent home available to him in both states or in neither State, he shall be deemed to be a resident of the Contracting State with which his personal and economic relations are closer (centre of vital interests).” If this rule doesn’t break the tie, we go to the next rule until the Treaty overrides domestic law to break the tie.
It isn’t only Thomson who has been caught in the trap of tax rules and residency. Because of the pandemic and its shelter-in-place requirements, many people find themselves as unintended residents of the other country. But the U.S. and Canadian governments have our backs on that for2020.
The Internal Revenue Service (IRS) will exclude days of U.S. presence if those days are the result of being ill with COVID-19. The U.S. Department of the Treasury also issued Revenue Procedure 2020-20 to extend a 60-day exemption to healthy people who were stranded due to pandemic-related travel restrictions.
The Canada Revenue Agency (CRA) website says those who have “stayed in Canada only because of the travel restrictions, that factor alone will not cause the CRA to consider the common law factual test of residency to be met.” In other words, treaty benefits will continue to apply and days spent stranded in another country will not count toward the 183-day test.
If you are considering getting “stranded” in the southern U.S. any time soon, make sure you talk to your professional adviser about any potential tax implications.
This article was originally published by The Lawyer’s Daily (www.thelawyersdaily.ca), part of LexisNexis Canada Inc.